March 18, 2010 / 4:42 PM / 9 years ago

TREASURIES-Bonds fall as supply move trumps tame inflation

* Investors begin to make room for next week’s note supply

* U.S. to sell $44 bln 2Y, $42 bln 5Y, $32 bln 7Y debt

* Profit-taking adds downward pressure on bond prices

* CPI shows no inflation; Philly Fed index rises a tad (Recasts lead, updates market, adds quote)

By Richard Leong

NEW YORK, March 18 (Reuters) - U.S. Treasuries fell on Thursday as investors cleared room for next week’s supply, overshadowing tame inflation data that reinforced the view the Federal Reserve can leave short-term interest rates near zero percent.

The Treasury Department, as expected, said it will sell $44 billion in two-year notes, $42 billion in five-year debt, and $32 billion in seven-year notes next week. The amounts matched what it sold in February as the government sought to finance its huge deficit.

“It will be hard for the market to digest the supply at these levels,” said Larry Milstein, head of government and agency trading with R.W. Pressprich & Co. in New York.

Benchmark 10-year Treasury notes US10YT=RR traded down 5/32 in price at 99-23/32 after hitting a session low of 99-18/32. The yield, which moves inversely to price, was 3.66 percent, up from 3.64 percent late on Wednesday.

Two-year notes US2YT=RR were down 2/32 to yield 0.96 percent, up 4 basis points from late Wednesday.

The spread between yields on 10-year notes and two-year notes, a gauge of the market’s inflation expectations, narrowed to 270 basis points, the tightest level so far this year.

The market initially was buoyed by a revived safety bid tied to Greece’s fiscal problems, but was unable to hold gains, snapping bonds’ four-day winning streak, traders said.

Treasuries also received support from inflation news. The U.S. Labor Department said its Consumer Price Index was unchanged in February from January, and the core rate, excludes volatile energy and food prices, rose 0.1 percent. For more, see [ID:nnOAT004535]

The CPI reading came a day after the Labor Department said the Producer Price Index posted its biggest monthly drop in seven months in February. On Tuesday, the Fed renewed its pledge to hold short-term interest rates near zero to support the economic recovery.

“Tame inflation is the get-out-of-jail-free card for the Fed, because as long as inflation stays low or trends lower as it’s doing they can wait for the labor market to come back longer than they would if inflation was to start trending up,” said Lou Brien, market strategist at DRW Trading in Chicago.

The yield gap between the regular 10-year note and 10-year Treasury Inflation-Protected Securities shrank 1 basis point to about 2.23 percent, signaling investors expect inflation will remain low.

Investors’ view of tame inflation did not change despite a slightly higher-than-expected reading on business activity from a regional Federal Reserve Bank.

The Philadelphia Fed said its index on business activity in the U.S. Mid-Atlantic region rose to 18.9 in March from 17.6 in February. Analysts had predicted a reading of 18.0. For more, see [ID:nTAR001018] (Additional reporting by Burton Frierson; Editing by Leslie Adler)

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